How influential is monetary policy on Ibovespa returns and volatility?

Purpose Is monetary policy neutral to Ibovespa index returns and volatility? To approximate neutrality, the Brazilian Government has implemented a system in which the financial sector’s economic agents contribute to their daily predictions about future expected monetary policy changes. The full implications of this policy innovation for the economy have yet to be assessed. Therefore, the purpose of this study is to investigate the effect of monetary changes on the mean returns and volatility of the Ibovespa Index. Here, monetary policy is proxied by market interest rate predictions uploaded to the Brazilian Central Bank database by the economic agents. Design/methodology/approach In the research design, multiple econometric model specifications were used, including Autoregressive Moving Average with Exogenous variables and Generalized Autoregressive Conditional Heteroskedasticity with Exogenous variables (ARMAX-GARCHX), Standard Generalized Autoregressive Conditional Heteroskedasticity with Exogenous variables (S-GARCHX), Exponential Generalized Autoregressive Conditional Heteroskedasticity with Exogenous variables (E-GARCHX), and Glosten-Jagannathan-Runkle Generalized Autoregressive Conditional Heteroskedasticity with Exogenous variables (GJR-GARCHX), with the best model selected based on the Akaike Information Criterion (AIC). Findings Our findings demonstrate that monetary policy is not yet entirely neutral because it influences the mean daily returns. The good news is that this system does not influence daily volatility. In summary, the evidence confirms that the government’s method of implementing monetary policy is in the right direction to neutrality in Ibovespa volatility. The results seem to support innovation and offer a model for other countries. Originality/value This study innovates by incorporating exogenous variables and enhancing the GARCHX model with optimized parameters and a distribution suited to the Brazilian context.